Economics 23/03/2010: Re-shuffling yields no trump cards

Let us first outline the conditions under which today's reshuffle took place:

• Earlier today Friends First Quarterly Economic Outlook predicted that after falling 50% since 2007, house prices will decline by 10% more this year. So the total drop through the cycle expected by Friends First is around 55%.
  

If house prices grow at 3% on average per annum, it will take us until 2038 before we recover the nominal losses in the property prices. If we are to assume that the spread between asking price premium paid in 2007 and asking price discount available today is 7.5% (+/-5%), to will take us until 2044 to regain the peak prices levels in nominal terms.

If property prices grow at 1.5% in real terms per annum (comparable to what has been happening in the better performing developed markets around the world since the 1960s), we will be able to restore 2007 levels of real housing wealth only in 2078, using the +/-5% discount/premium spread, or 2064 if we just take asking prices.

The previous Cabinet, absent three exceptions, has presided over this boom and the bust. The re-shuffled one did as well. Is this a dramatic departure from the policies of the old?

• Second, also today, a report from PwC has forecast that the Irish economy will shrink by 1.3% this year, before returning to growth of around 1.8% in 2011. This means that peak to trough PWC expects economy to contract 12% in terms of GDP, and approximately 16.3% in terms of GNP. PWC forecasts that economy will return to growth of around 1.8% in 2011.
  

Assuming this will be the 'new normal' on average, it will take Ireland Inc until 2019 to regain the nominal levels of GDP we enjoyed at the peak of the bubble and until 2021 to do so in terms of domestic economy income.

I am not going to outline the rest of the bleak conditions that form the backdrop to today's cabinet reshuffle, but it was clear from the beginning that a significant change in the Cabinet was required if the country were to have any hope of change in policies.

Which brings us to the new Cabinet formation:

Below, I will marks Taoiseach's decision out of 5 points maximum possible corresponding to 'Excellent' with 0 corresponding to 'Extremely Poor'. These scores do not attempt to rate individual Ministers past performance, but rather the decision made by Taoiseach in making new appointments.

• Mary Coughlan - Tánaiste, Minister for Education and Science – No comment – the title says everything… 0/5
• Brian Lenihan - Minister for Finance – the best we can do in this Cabinet… 5/5
• Mary Harney - Minister for Health – the only person willing to take the poisoned chalice and run with it for 6 years… 5/5
• Noel Dempsey - Minister for Transport – a safer bet, despite a number of high profile errors (T2 contract to DAA, etc) and insistence on a number of White Elephants, e.g. Metro North – 3/5
• Dermot Ahern - Minister for Justice, Equality and Law Reform – a better candidate for an economics post, but a good call for his current post as well. Ahearn deserved a promotion by virtue of being a more promising senior and experienced figure for key post and in this environment. Economics posts are the key ones – 3/5
• Micheál Martin - Minister for Foreign Affairs – best suited for his current role - 5/5
• Éamon Ó Cuív - Minister for Social and Family Affairs – think ‘experience’ (though he did run Gaeltacht Affairs - a largely welfare scheme) - 0/5
• Mary Hanafin - Minister for Arts, Sport and Tourism – Mary Hanafin deserved a much greater role in the Cabinet, with good potential to run an economics portfolio, her placement in Arts, Sports and Tourism is an opportunity foregone, 0/5
• John Gormley - Minister for Environment, Heritage and Local Government – this is a purely political balancing act, 2/5
• Eamon Ryan - Minister for Communications, Energy and Natural Resources – see John Gormley, 2/5
• Brendan Smith - Minister for Agriculture, Fisheries and Food - a very significant portfolio especially when one recognizes the role of food exports in total indigenous exports– see Eamon O Cuiv above, 0/5
• Batt O'Keeffe - Minister for Enterprise, Trade and Innovation – possibly an interesting move, risky, but… Batt O’Keeffe did some honest, if strangely inconsistent work in DofE. His record, ranging from brave and intriguing to unexplainable, should be interesting to watch at DETI. But is this a ‘steady, strong hand’ that one needs to move things forward in the second most important department in the country? I simply do not know. So: 3/5.

Average score: 28/60 or 47%. It won’t earn one a pass in a post graduate programme course.

Now to the second test – the rearranging of the chairs floating over the spot where Titanic sunk:

• The Department of Enterprise and Trade is now to take responsibility for Innovation. And lose responsibility for Employment. Given that DETE used to be one of the more competent of all departments in the past, this clearly suggests that the Government has no real policy platform for combating unemployment. Score on decision: 0/5.
• The Department of Education is to become the Department of Education and Skills. DofE has no capability or experience in dealing with the matters of skills. VAC schemes that it runs are shambolic at the very best and never were benchmarked or tested properly. To acquire expertise it would need FAS, plus some Forfas capabilities, plus access to multinational and domestic employers. DofE - focused on the needs of secondary education sector since its foundation - simply cannot be expected to deploy an enterprise-centred culture needed to build them. Score on decision: 1/5.
• The Department of Social and Family Affairs will become the Department of Social Protection - it will take responsibility for FÁS. Which now puts our Government into a position of formally admitting that FAS ‘training’ schemes are nothing more than social welfare designed to artificially reduce (temporarily) the Live Register counts. Furthermore, DofSocial Protection has neither expertise nor experience in dealing with training. This decision further fractured the employment training and skills policy. It also created an interesting conundrum. FAS has various embedded and affiliated bodies which include participation from private sector leadership. We are now likely to find ourselves in a comical scenario where private corporate leaders will be asked to provide public service to Social Welfare. Score on decision: 0/5.
• Equality is to go into the Department of Community and Gaeltacht affairs. This, of course, is a purely optical announcement with no real meaning, other than the potential for creation of new public sector employment - 0/5.
• Mr Cowen also announced the setting up of a Public Service Board, which aims to accelerate public service reform in consultation with the unions. Amazing: after a clear show of intransigence on reforms, the unions are now formally incorporated into the process of reforms. This legislatively establishes a one-sided form of sub-Social Partnership as an official part of the State – 0/5.
• Junior minister Dara Calleary will also be assigned to push through change in the public service. Junior ministry allocation to reforming something that accounts for over 40% of our economy? For over 1/3 of our entire Exchequer Budget? Combined with the PSBoard announcement, expect no reforms of any sort to come out within the life of this Government. 0/5 folks.

Total score on the Cabinet change and new ‘reforms’ of Departments: 29/90 or 32% - a Fail even in an undergraduate course.

Per RTE report: “Announcing his changes, the Taoiseach said he was not in favour of structural changes for their own sake and said the benefits the changes bring will outweigh the costs.” Read: no costings have been made, no benefits assessment was done.

Prepare yourselves to another Government that provides policies-based evidence instead of pursuing evidence-based policies.

Economics 21/03/2010: Reckless expectations, not competition

This is a lengthy post - to reflect the importance of the issue at hand. And it is based largely on data from Professor Brian Lucey, with my added analysis.

The proposition that this post is proving is the following one:

Far from being harmed by competition from foreign lenders, Irish banking sector has suffered from its own disease of reckless lending. In fact, competition in Irish banking remains remarkably close (although below) European average and is acting as a stabilizing force in the markets relative to other factors.


I always found the argument that ‘too much competition in banking was the driver of excessive lending’ to be an economically illiterate one. Even though this view has been professed by some of my most esteemed colleagues in economics.

In theory, competition acts to lower margins in the sector, and since it takes time to build up competitive pressure, the sectors that are facing competition are characterized by stable, established players. In other words, in most cases, sectors with a lot of competition are older, mature ones. This fact is even more pronounced if entry into the sector is associated with significant capital cost requirements. Banking – in particular run of the mill, non-innovative traditional type – is the case in point everywhere in the world.

As competition drives margins down, making quick buck becomes impossible. You can’t hope to write a few high margin, high risk loans and reap huge returns. So firms in highly competitive sectors compete against each other on the basis of longer term strategies that are more stable and prudent. Deploying virtually commoditized services or products to larger numbers of population. Reputation and ever-increasing efficiencies in operations become the driving factors of every surviving firm’s success. And these promote longer term stability of the sector.

Coase’s famous proposition about transaction costs provides a basis for such a corollary.

This means that in the case of Irish banking during the last decade, if competition was indeed driving down the margins in lending (as our stockbrokers, the Government and policy analysts ardently argue today), then the following should have happened.

1. Banks should have become more prudent over time in lending and risk pricing,
2. There should have been broader diversification of the banks lending portfolia, with the bulk of new loans concentrating in the areas relating directly to depositor base – corporate and household lending, and a hefty fringe of higher-margin inter-mediation lending to financial institutions, and
3. Banks would be seeking to ‘bundle’ more services to differentiate from competitors and enhance margins.
   

In Ireland, of course, during the alleged period of ‘harmful competition’ exactly the opposite took place. Let me use Prof Brian Lucey’s data (with added analysis from myself) to show you the facts.

Firstly, Irish banks became less prudent in lending – as exemplified by falling loans approvals criteria, and by rising LTVs:

1. Lending to private sector as % of GDP was ca 50% in 1995, reaching 100% in 1998 and rising to 300% in 2009
2. Vast increases in lending to developers: in 1997 there were €10bn lent out to developers against €20bn in mortgages; in 2008 these figures were €110bn and €140bn respectively
3. Over the time when lending to private sector rose 600%, mortgages lending rose 550%, our GDP rose by 75%
   

Secondly, banks reduced their assets and liabilities diversification (charts 1-3 below) setting themselves up for a massive rise in asymmetric risk exposures.

On the funding side, out went customers deposits, in came banks deposits, foreign deposits and bonds and Irish bonds.
Capital ratios fell out of the way.

And so there has been a change in the world of Irish banking that no other competitive and mature sector of any economy has ever seen. Why? Was it because foreign banks started pushing the timid boys of BofI and AIB and Anglo and INBS out into reckless competitive lending?

You’ve gotta be mad to believe this sop. In reality, the Irish banks’ assets tell the story.

Business loans collapsed, personal loans (the stuff that allegedly, according to the likes of the Irish Times have fuelled our cars and clothing shopping binge during the Celtic Tiger years) actually declined in importance as well. Financial intermediation – the higher margin, higher risk thingy that so severely impacted the US banks – was down as well. No, competition was not driving Irish banks into the hands of higher margin lending. It was driving them into the hands of our property developers. We didn’t have a derivatives and speculative financial investment crisis here – the one that was allegedly caused by the foreign banks coming in and forcing our good boys to cut margins on run-of-the-mill ordinary lending. No, we had an old fashioned disaster of construction and property lending.

And this lending could not have been driven by foreign banks. It came from the total expansion of credit in the economy, presided over by our Central Bank and Financial Regulator, our Government and ECB.

Just how dramatic this change was? Take a look at the ratio of private sector credit to national income in the chart below.
Even a child could have seen the bust coming. The reason that our Financial Regulator and Central Bank failed to see this, despite publishing all this data in the first place, is that they were simply not looking. The former probably obsessed with the pension perks, the latter – well, may be because all the fine art in the Central Bank’s own collection was just too much of a distraction. Who knows? But judging by the above chart lack of significant correction during the crisis – we know who will pay for this in the end. Us, the taxpayers.
As chart above shows, the fundamentals for the boom – in lending and in construction – were never there, folks. And the banks missed that completely. As did our regulators and our policymakers. Brian Lucey of TCD School of Business provides evidence on what was really going on in the Irish banks (again, note that some of the analysis below is mine).
Chart above, based on the Central Bank Credit Survey, basically shows the impact three major forces: expectations of increased competition by the banks, improved banks outlook on the Irish economy three months ahead, and LTVs expectations had in Irish banks willingness to increase lending. Scores above 3 represent tightening of credit conditions (as in banks expecting to cut lending to households), while scores below 3 show forces driving looser credit to households.

If the proposition that foreign banks competition pressures drove Irish banks into looser credit supply were to be correct, one would expect the blue line above to reach far deeper into ‘below 3’ scores than the other two lines. Alas, it did not dip. In fact, competition from other banks was recognized by Irish Bankers themselves to be the least improtant factor contributing to credit supply expansion. Instead, their over-optimism about economic prospects (red line) and their willingess to give away cash at massively inlfated LTVs (the orange line – also a proxy for Bankers’ optimism regarding future direction of house prices) were the two main drivers of credit boom.

Where’s the evidence on ‘harmful competition’ that so many Central Bank leaders, the stockbrokers and Government spokespersons have decried in recent past?

The delirium of our bankers was actually so out of any proportion that, as the surveys data shows, even amidst the implosion of the housing markets since early 2008 they were still saying “hang on....we expect that changes in LTV and economic prosoects will cause us to loosen in the next 3 months". In other words, they were chasing the deflating bubble, not the imaginary foreign banks competitiors.

Let’s take another look at Brian Lucey’s data. Take the scores for Ireland in the above surveys and take their ratios to the Euro area average scores. If the ratio is in excess of 1, then the said factor has contributed to greater tightening in credit supply in Ireland than in the Euro area. If it is less than 1, then the said factor has contributed more to loosening in lending in Ireland than in the Euro area.
So, really, folks, competition in Ireland was actually more of a stabilizing force, than de-stabilizing one. LTV’s optimism and lack of realism in economic forecasts were the two main driving forces of the boom.

Lastly, ECB Herfindahl Index (ratio of Ireland to “big5” EU states) provides exactly the same conclusions:
Again, what above shows is that on virtually every occasion, Irish reading for Herfindahl Index (measuring degree of concentration in banking sector) is in excess of the average Index reading for top 5 EU countries. In other words, there was no such thing as ‘too much competition’ going on in Irish banking sector. If anything, there was somwhat too little of it, compared to Germany, France, Italy, UK and the Netherlands.

And now, for the test of all of this. The chart below regresses each survey factor on the private sector credit index. The negatively sloped line – for LTV and economic prospect factors combined - shows that when this factor scoring in the survey increased, lending became tighter. Positively sloped line – for competition – shows that when competition pressures rose (factor reading declined), lending actually got tighter. And the statistical significance of the LTV and expectations factors is more than double that of competition...
Let’s just stop talking nonesense about too much competition in Irish banking sector drove unsustainable lending. More likely – an anticiaption by our bankers that no matter what they do, they will never be allowed to fail by the state, plus an absolutely rediculous expectations about opur economy drove our banks to the brink.

Economics 18/03/2010: Services Inflation in Ireland

CSO released an interesting set of new stats on price inflation in select services. Per experimental Services Producer Price Index (SPPI) average prices charged by domestic service producers to other businesses in Quarter 4 2009, were on average 4.1% lower in the year when compared with the same period last year.

The most notable changes in the year were:

• Architecture, Engineering and Technical Testing (-9.7%),
  
• Computer Programming and Consultancy (-8.5%),
• Advertising, Media Representation and Market Research (-7.2%),
  
• Freight and Removal by Road (-5.2%) and Air Transport (+6.3%).
  

Services Prices increased by 0.4% in the quarter. This compares to a decrease of 2.3% recorded in Q3 2009.

The most significant quarterly price decreases were in

• Freight and Removal by Road (-2.2%),
  
• Postal and Courier (-1.4%) and
  
• Sea and Coastal Transport (-1.4%).
  

There was an increase of 4.8% in Air Transport.

Now, what CSO report did not show is the following. While deflation in higher value added, human capital-intensive services was rather significant, mid-range value-added services saw much more moderate deflation, with low value added labour-intensive sectors such as security services holding up almost unchanged over time. Chart below illustrates:
For all the talk about improved competitiveness, transport-related services costs are still on the upward trend:
And this is before Carbon Taxes kicked in.

Another interesting point to be made here is that the first chart above appears to suggest that deflation is almost not happening at the level of sectors that are labour intensive - industries most impacted by the minimum wage. In more wage-flexible sectors, where human capital drives value added to much higher levels, inflation is running negative. This has two implications going forward, should this trend persist:

1. Despite all the talk about the 'poor' bearing the brunt of the crisis, at least as far as prices charged for services indicate so far, there is most likely stronger deflation of wages at the higher end of wages distribution;
2. While competitiveness of our traded and higher value added services is increasing, competitiveness of our domestic services (anchored in higher labour intensities) is not improving significantly.
   

Economics 18/03/2010: A new warning to Ireland

Ireland was put on notice in the EU Commission assessment of fiscal positions going forward. per FT report today: European Commission warned eight countries, including Germany, France, Italy and Spain, Austria, Belgium, Ireland and the Netherlands that their forecasts for fiscal deficits reduction and growth for the next 4 years are basically failing to meet reasonable tests of robustness and that they need to identify exact measures they will take to meet their medium-term deficit reduction targets of 3 per cent or less of gross domestic product.

This is a second round of warnings covering Ireland's budgetary plans after earlier this month the ECB has qualified its assessment of Euro area fiscal consolidation measures with a statement, in the case of Ireland, referring to the lack of clear evidence on the ways in which the target will be achieved (see ECB Monthly Bulletin, 03/2010 page 85).

The warnings - usually a saber-rattler, and nothing more - but this time around it is a serious note. The reason is simple. It now appears that Germany is set against a direct bailout for Greece, pushing instead for joint IMF/Euro area action backed primarily by IMF. Here is the background on this:

Bloomberg reports (here) that Michael Meister, the CDU’s finance spokesman, said: “We have to think about who has the instruments to push for Greece to restore its capital-markets access... Nobody apart from the IMF has these instruments,” and that attempting a Greek rescue without the IMF “would be a very daring experiment.”

Angela Merkel told the German parliament yesterday: “The problem has to be solved from the Greek side and everything that is being considered has to be oriented in that direction.”

This clearly implies that fiscal deficits corrections will have to be pursued by countries in the environment where the markets cannot price in collective risk averaging within the Euro area, which in effect means that spreads between German and PIIGS bonds yields will have to rise and stay elevated through 2014. And this, in turn, means Ireland is now exposed to a potential sever credit crunch on the Government side.

And there is an even greater threat for Ireland, as Irish Exchequer is much more dependent on the good will of German banks than any other Exchequer in the PIIGS club (see chart below, courtesy of http://spaineconomy.blogspot.com/):
Frightening, especially since the chart is expressed in Euros, which of course puts us well ahead in proportional terms of Spain, not to mention Portugal and Greece, for all countries, except Switzerland.

Economics 17/03/2010: Nama Estimation Procedures

Yesterday I finally got a few minutes to read through the latest Government documentation on Nama - "Determination of Long-Term Economic Value of Property and Bank Assets" regulations SINo88 of 2010 from March 5 (link here). This delightfully thin document is a treat for anyone who cares to study just how inept our authorities can be when it comes to measuring and assessing/pricing risk.

Timing

Paragraph 2 page 2 defined 'relevant period' - used in assessing long-term economic value - as 'the period that began on 1 January 1985 and ended on 31 December 2005'. Per para 5.ii page 3, this period will be used to estimate reference prices for land based on land hedonic (econometric) links to demographic variables (5.b.i), interest rates (5.b.ii) and GDP (5.b.iii).

The problem here is that there is no clear identification as to which time horizon (the full 21 years worth or some sub-set thereof) the Government will use. And this is crucial, as this period largely covers steadily rising market with almost no corrections. Which means that should Nama use dynamic trend for estimating the land prices, it would be rather accurate within the sample, but will be absolutely ad hoc outside the sample (per Lucas critique).

Of course, Nama won't take dynamic pricing - and as is clear from 5.(1).(a).(i) and (ii) it is going to take 'prices' and 'yields' - i.e. point estimates. Which most likely means some sort of an average. It is important, therefore, to have an exact idea as to within what sub-period of 1985-2005 is this average going to be taken. The note does not identify this exactly, leaving the door open for Nama to deal with the data as it sees appropriate.

Discount factors

There is an added complication to the entire valuations scheme. SSNo88 states in 5.(1).(a) that a discount (adjustment) factor for land located within the State will be based on a difference in price of land on valuation date (nearly absolutely unknown to Nama) and the Long Term (economic) Value (LTEV) price (also unknown to Nama). And this means that Nama will start its valuations process by applying an unknown discount factor to a risky asset it is buying. No data listed within SSNo88 as the basis for valuations allows Nama to escape this grim reality.

Discount Rates

There are other fundamental errors built into valuations process. For example, NAMA discount rates - equivalent to interest rates - on bank assets are (as listed in 2.(2).(a)-(b) on page 2: 4.54% for 3-year rate, 5.57% for 5-year rate, and 6.16% for 8-year rate. This presents a little bit of a conundrum. Firstly, are these rates annualized compounded or simple? Second, and even more important - why are these rates chosen for these maturities? What yield curve has been used to impute these? No clarity on this whatsoever.

ECB gives only two types of average retail rates for non-financial corporations loans: as of January 2010 (the latest), we have existent loans with rate fix up to 1 year are priced at 2.96% which, factoring in Government's 1.7% risk premium margin implies a rate of 4.66%, not 4.54%. Off the starting line, there is a built in subsidy from Nama.

And this subsidy is greater than 12bps spread between the above two rates. How I know this? Well, think - can assets we are buying into Nama attract any loans in the private sector? At any valuations? No. So what justifies that 1.7% risk premium the Government applies (per 2.(2).(a)-(c)) to all loans it will be buying? And why is the risk premium independent of maturity period? Surely it should be rising with maturity?

Let's take a look at what we have from the ECB: non-financial corporate overdraft rate as of January 2010 averaged in Ireland at 5.74%. Suppose this was the basis for our Nama valuations (I still think this is too low of a rate given the assets quality and given the fact that ECB reports 'offer' rates by the banks, not the actual rates on which loans were issued, but what the hell, let's use this as a base assumption).

With Government risk premium, this should imply a 3-year discount rate of 7.44% (still shy of corporate junk bonds, but much better than 4.54% built into Nama). This rate (per 7.(a)) will cover land-backed loans where land value has fallen just 10% below its LTEV - the high quality loans in Nama books. Now, using SSNo88-implied yield curve, 5-year discount rate consistent with our assumed base rate should be 2.08% and for 8-year rate, the risk margin should be 1.9%.

This means that if Nama were to use the riskiest loans rates we have - those for overdrafts by non-financial corporate sector, and use upward sloping risk margins (to reflect the fact that the longer the duration of the rate, the lower is the quality of assets to which it applies - per SSNo88 page 5 own admission), the rates of interest imputed on Nama assets should be:

• 3-year money - at 7.44%, not Nama-assumed 4.54% (a loss to the taxpayer or a subsidy to developers and banks of 2.9% per annum);
• 5-year money - at 9.13%, not Nama-assumed 5.57% (a loss to the taxpayer or a subsidy to developers and banks of 3.56% per annum); and
• 8-year money - at 9.67%, not Nama-assumed 6.16% (a loss to the taxpayer or a subsidy to developers and banks of 3.51% per annum).

Let me give you a look at the Nama interest rate pricing generosity from another angle. Irish Exchequer is currently borrowing at 5% interest rate in the markets. This, presumably does not include Mr Lenihan's 1.7% risk margin. Which means that if Nama was buying loans from borrowers who are as credit-worthy as the Irish Exchequer, it should be applying a rate of 6.7% to these loans. My estimate of 7.44% is much closer to that than SSNo88 statutory fixed rate of 4.54%.

Proposition: under Nama, effective interest rate subsidies for defaulting loans (accruing to banks and developers) will range between 2.9% and 3.56% per annum.

Proof: see two alternative arguments above.

Estimation process

Another issue, related to interest rates arises when the SSNo88 outlines 3 sets of variables Nama will use to impute LTEV based on 'correlation' (whatever this means in econometric terms, I have no idea): 'between land prices and interest rates in the State' (5.(1).(b).(ii)). Can someone explain to me which interest rates Nama has in mind? Central Bank rates? Retail rates? Retail rates for non-financial corporations loans?

The same applies to paragraph (5.(1).(c)).

Valuations timing

The document SSNo88 was published in March 2010. Nama will not begin valuations before April and will not finish these before the end of 2010 (optimistic projections). So why are all valuations being made by Nama will take into account only market values of land prior to January 10, 2010? Surely, falling markets mean - and consensus forecast expects - at least 5%+ decline in house prices (what can one say about land!) over 2010. Is Nama going to ignore this reality and price the assets in buys in, say, November 2010 at prices valuations for January 2010?

Let me explain. In a year when I bought my house, within 11 months of my purchase, home prices fell roughly speaking 3%. Do I get to go to my bank and tell them - 'Folks, shave off 3% from my total original mortgage as Nama is doing for you?'

5% is a non-trivial number, adding up, over the loan book Nama id about to take up roughly €3.9 billion overvaluation, spread over 15 years with interest and market discounts accruing to it.

Use of GDP

SSNo88 applies to valuations of land and real estate assets. These are non-exportable. Why is then the Government planning to use the rates of growth in GDP, not GNP? Does our booming (1985-2005) pharma sector has anything to do with the fundamentals on which land prices are set? Using GDP for the estimation process instead of GNP introduces a distortion of between 12% and 18% depending on the range of years used. This distortion risks further overvaluing the LTEV for land.

Building in dreamy planning

Paragraph 5.1.d.ii states that Nama will use "existing and future transport planning and the associated supply and demand projections for land use" in its valuations of LTEV. What does this mean? Will Nama use full extent of NDP plans? Including the frozen and indefinitely postponed plans? There is significant divergence between what is planned and what is delivered. And in the next 10 or so years, this divergence will be in the direction of planned transport investment being well in excess of real investment. If Nama were to use the former as a basis for estimates, then there will be land with LTEV in excess of realizable value because its estimated LTEV will be based on excessively optimistic plans for transport investment.

At any rate - the current phrasing of the SSNo88 does not provide for a rigorous definition of what planned infrastructure will Nama actually factor in. This makes the LTEV estimation process outlined in LTEV completely undefinable under the current legislation.

Land based outside the State

The entire section 6 outlining the LTEV estimation process for land outside the State is simply a carbon copy of the valuation processes for LTEV within the State. This suggests that - given that assets being valued are different in nature (legal and economic), risk and geographies - the Minister has no idea how these different risks should be reflected in the estimation process.

The section does not even mention exchange rate risks or derivatives on Forex exposure attached to loans. There is no clear understanding as to what interest rates should apply and how to deal with the carry trades.

Operational costs

Section 8 of the note states that the assumed 'due diligence costs, incurred or likely to be incurred by Nama over its lifetime' is 0.25%. This is simply unrealistic. Industry average operating cost on performing loans - across all subheads - is equal to about 0.75-1% in times when operating conditions are deemed to be normal. As of the end of February 2010, Nama, reportedly already has blown through its entire 2010 legal budget. How can 25bps cover its due diligence cost over life time?


In short, SSNo88 is yet another document that shows just how exposed Nama remains to shoddy planning and poor estimation procedures, courtesy of the DofF that simply cannot deliver realistic and transparent operational guidelines.

Economics 17/03/2010: Stuck in the Euroland

The silver lining to the ongoing PIIGS crisis in the Euroland is that finally, courtesy of the severe pain inflicted by the bonds markets, Brussels (and more importantly the core nation states) is forced to face the music of its own making.

I wrote for years about the sick nature of the European economy - at the aggregate levels and individual countries cases. Today's FT Alphaville article by Lombard Street Research’s Charles Dumas (here) offers another great x-ray of the issue:

Dumas' chart clearly shows just how sick the core Euro area economies are and how structural this sickness is. With exception of the bubble-driven catch-up kids, like Spain, the Euro area has manged to miss the growth boat since the beginning of the last expansion cycle.

"The chart above shows real GDP growth from the end of the last recession… Germany is placed evenly between the Sick Man of Europe, Italy (with no growth at all – the very fact of EMU membership has been enough to crush Italy), and the Sick man of the World, Japan (which at least managed nearly 1% annual growth). Germany’s pathetic advance over eight years was 3½%, less than ½% a year, and one third of the growth of Britain and France…" But France, and the UK, have managed roughly 0.975% annualized growth over the same time. Comparing this to the US at 1.27% puts the picture in clearer perspective.

The problem, of course, is much greater. I wrote before that the real global divergence - over the last 10 years - has been happening not via the emerging economies decoupling from the US, but via Europe's decoupling from the rest of the world. The chart above clearly shows that this significant in economic terms (as the gap between European 'social' economies wealth and income and the US/UK is still growing). But the chart also shows that Europe is also having a much more pronounced recession than the US.

Europe's failure to keep up with the US during the last cycle is made even more spectacular by the political realities of the block. Unlike any other developed country or block, EU has manged to produce numerous centralized plans for growth. Since the late 1990s, aping Nikita Khruschev's 'We will bury you!' address to the US, Brussels has managed to publish a number of lofty programmes - all explicitly aimed at overtaking the US in economic performance. All promised some new 'alternative' way to growth nirvana: Lisbon Agenda was followed by Social Economy, which was displaced by the Knowledge Economy. The latest installment - this year's Agenda 2020 is a mash of all three - the strategies that failed individually are now being mixed up in a noxious cocktail of economic policy confusion, apathy and sloganeering.

But numbers do not lie. The real source of Euro area's crisis is a deeply rooted structural collapse of growth. No amount of waterboarding of the real economy with cheap ECB cash, state bailouts and public deficits financing will get us out of this corner. Tax cuts paid for through fiscal spending reductions could have helped in the long run by deleveraging Europe's economy out of the state control bubble. But this opportunity is now firmly wasted through unprecedented amounts of deficit financing deployed in 2009-2010.

Never mind Greece and the rest of PIIGS, EU has no growth engine to get ourselves out of the Japan-styled (or shall we call it Italy-styled) long term stagnation.

Economics 16/03/2010: What's wrong with 'spend now' economic development

Please, tell me if I have woken up on some planet called 'Wealth, Prosperity and Boom Times'? The last couple of weeks have positively turned into some sort of a macabre Hollywood serial where by every other day some new 'Group', 'Taskforce' or a plain 'White Paper' or 'Strategy' comes out with a cheerful idea of spending more money we do not have on thing we do not really need. All of this is cloaked in a veil of economic 'programmes' and 'targets' that inevitably promise thousands/tens-of-thousands/hundreds-of-thousands of new and ever-better-paying jobs sometime in the next 10 years.

I stretch my arms, rub my eyes and slowly rise to the dawn of the 'new prosperity'. For prosperity, with a massive capital 'P' is what it will take to actually get a single job out of the Innovation Task Force, the TASC L28, the Farmleigh Report... and now, the ideas that some of our University heads have.

So let me briefly outline another Grand Project 'Irish Awakening' installment. Albeit more modest (it would only cost a handful of million to set up and as much to operate annually), the idea of setting up a separate Minister (with her own Department) for the 3rd level education, floated out by DCU president Prof Ferdinand von Prondzynski in the end bears about the same relation to addressing the real problems of Ireland Inc as Eskimos' annual seals hunt does to flyfishing in New Zealand.

Prof Prondzynski is right in identifying continued underfunding of our universities as a major problem. I agree with him here, although we disagree (and only partially) on what this funding should deliver and also on where it should come from.

But setting aside these differences, how can such an experienced and accomplished university head confuse the appointment of a high office of a Minister with a functional policymaking and regulatory/funding outputs? All that a separate Ministry would do is suck massive amounts of funding to finance pay and perks of its own employees, sprinkled with rows upon rows of addictive junkets for the Minister and her entourage.

Take current 50 bureaucrats administering Universities funding. Put them into a separate Department, appoint a senior minister for that and you have 80-100 headcount of new paper pushers. The cost? Oh, at an average wage in the public sector, plus trimmings, plus employment-associated costs, junkets and so forth - conservatively starting at €8 million per annum. Oops, there goes a large chunk of funding for some 3rd level institution.

More fundamentally, to say that adding a new layer - whether independent or not - of bureaucrats to the already cumbersome, nearly Byzantine system of controls, budgetary appropriations and regulatory constraints will make Universities funding any more visible or transparent is a strange sort of logic.

The problems with our Universities funding can be ranked, in terms of their gravity, and thus priority, as follows:

1. Lack of direct relation between university performance (in terms of quality of its academic research and teaching) and funding (disconnect between end-user / customer - corporate and students). This can only be resolved through introducing fees-based competition and through more direct corporate funding of research (not as a pure substitute for public funding, but as enhanced addition to it). Setting a Ministerial office for 3rd level institutions will do nothing here;
2. Lack of direct managerial capability over staffing (the problems of centralized wage setting and tenure). Again, this cannot be addressed through a Ministerial remit, but will have to involve decentralization of management and finances to give Universities more autonomy;
3. Lack of private sector funding for R&D - a problem that is extremely acute and cannot be resolved through any Ministerial diktat. Only significant improvement in research system transparency, allowing the best universities and researchers (including those from DCU, where Prof Prondzynski should be credited with achieving serious and positive transformation on research front) to directly and openly compete for research funding can do the job. If anything, Universities research funding activities must be also seen as a potential avenue for exports from Ireland of knowledge economics and in this, Universities can and should be assisted by Enterprise Ireland and other export-development agencies. Again, however, a separate Minister for 3rd level education will do absolutely nothing here.
4. Difficulty of accessing new R&D funding streams (e.g EU funds). Again, to address this problem Universities need to become more competitive and more aggressive in cutting through the fog of 'collaborative research' simulacra. Only truly productive collaborative research should be pursued and the idea that collaboration is of value on its own - as currently pursued by our funding authorities - must be dealt away with. This cannot be done through more centralization of decision making - as consistent with single Ministerial authority.

So none of the real problems and opportunities faced by our Universities require a new Ministerial post. And, of course, our budgetary constraints hardly permit such a lavish addition to the ranks of policy boffins.


And thus, returning back to the general theme of economic policy by 'borrow more now to get hundreds of thousands of jobs tomorrow', let me tell you an ancient fable that aptly describes what I think of all the proposals for setting spending-based targets for future growth. Back in the Middle Ages - around 13th century - there was a great character employed by Sultan. His name was Hoca Nasreddin. One day he came to his friends to tell them that he was just employed by Sultan to teach Sultan's pet donkey how to read. His friends were alarmed, as none of them believed this can be done. They were concerned that Sultan, upon learning of Nasreddin's inevitable failure to perform the task will have Nasreddin's head cut off. "Do not worry, my friends," replied Nasreddin. "In ten years, when contract is up, either Sultan will be dead, the donkey will be dead or I will be dead."

Ditto for all the promised hundreds of thousands of jobs by 2020 - how many heads of authorities or political leaders responsible for producing these targets today are likely to be there in 2020 to account for these plans? Of course, in the mean time, they all want us to pay for these now. Spot the fools in this scheme?

Economics 15/03/2010: The failure of the state is a failure of society

Here is an unedited version of my article in the current issue (March-April 2010) of Village magazine.

Pull Quote: “Replacement of foreign élites with domestic elites was the main objective of Ireland’s change.”

“It only stands to reason that where there's sacrifice, there's someone collecting the sacrificial offerings…The man who speaks to you of sacrifice is speaking of slaves and masters, and intends to be the master”. Ayn Rand.

“”Sacrifices needed for recovery”, says Cowen.” Irish Times headline 5^th Feb 2010


The fundamental problem with Irish politics is not our much-decried proportional representation electoral system or the absurd subatomic fragmentation of politics into parish-pump power brokerages. The most rotten aspect of our political environment is the culture of clientelism that underlies the foundation of society. To understand this, take a quick detour back in time. The American Revolution and the Irish struggle for self-determination had a common adversary – the British Empire. But this is where the similarities end.

American Model

The US was founded on the core idea that without British rule, the ordinary people could improve their own governance. The Declaration of Independence is rooted in the Enlightenment, which informs its outline of where the Brits have gone wrong: not so much in underwriting the entitlements of the people, but in directing the policies of the land. Although most scholars tend to focus on the opening lines of the Declaration, denigrating the remainder as a laundry list of British offences, in reality both parts of the Declaration are pivotal to the balance of power between the individual and the state. The Declaration clearly posits the state as the tool for implementation of the new order. Not as the order itself. In Ayn Rand’s terms, American statehood is not about sacrifice of an individual for the sake of the collective, but about removing the state from the position of delineating slaves from masters. The US was formed not as a sacrifice of the few for the sake of the many, but as a project for improvement of opportunities for all.

Irish Model

The Irish state was born out of a more limiting premise - that, without British rule, native elites can be just as effective (or ineffective). Replacement of foreign élites with domestic ones was the main objective of Ireland’s change. In religion, administration, property rights, culture, society and economics, the Irish Revolutionary movement, justifiable as it may have been, accomplished only the equivalent of a coup d’état, leaving ordinary people in semi-servitude to the new, this time around native, political and administrative master-class.

Out of the necessity to bow to modernity, we added a second tier to our traditional economic structure. Ireland Inc - multinationals and exporters responding to global markets and incentives – is now juxtaposed against the clientelist domestic sector run on the back of parochial interests. Ireland’s gross public expenditure in 2009 reached €76.2 billion or 57.3% of our national output. Including our semi-states and state-licensed activities, over 70 cents of each Euro circulating within Ireland is now state-controlled. Irish domestic economy in thus equivalent to a teenager with a job at a fast-food joint who lives with his parents. Over 65% of the population is in some sort of direct dependency on the state – either as its employees or as the recipients of its subsidies. This in itself accounts for the weddedness of so much of the population to the strong state.

Constraining the State

Last month, MIT Professor Daron Acemoglu, published a paper entitled, Institutions, Factor Prices and Taxation: Virtues of Strong States? As Acemoglu shows, strong states conduce to redistribution of resources and thus, to an even greater capture of the state powers. The fraught UK experience implies that efficient, functional states require more external checks and balances, not the vesting of more autonomy and power in the state institutions. This flies in the face of the Irish political ethos, which sees the state as a combination of a powerful autonomous bureaucracy and the clientelist political establishment. But it also puts into a historic perspective the serial failures of Irish society to revolutionise our state structures.

Ireland never had England’s Cromwellian experience of the renewal of élites. Nor did we have a full-blown industrial revolution to deny the idea of clan-based power. We missed out on the Thatcherite revolt against the ideological elevation of society over individual rights. Once again, Ayn Rand captures the point: “Individual rights are not subject to a public vote; a majority has no right to vote away the rights of a minority; the political function of rights is precisely to protect minorities from oppression by majorities (and the smallest minority on earth is the individual)”. Whatever position one might occupy in terms of party politics in Ireland, we must surely agree that any society based on the insistence of SIPTU-ICTU-CPSU that the Social Partnership overrides the individual, is simply incompatible with liberal democracy protective of individual rights.

Liberalism Vs. Statism

Rand’s scepticism about the compatibility of state interests and universal personal liberty separates the liberalism (that Ireland’s national institutions never managed to learn) from neoliberalism (to which we have developed a cross-party devotion). Stephanie Lee Mudge of the European University Institute defines neo-liberalist politics as “struggles over political authority that are bounded by a particularly market-centric set of ideas about the state’s responsibilities… and the state’s central constituencies (business, finance and middle class professionals)”. Of course neoliberalism is nothing more than a conservative, status quo preserving ideology - it's struggles against authority are a form of resistance against a change of elite, not in favor of change. Unlike neoliberalism, liberal principles do not identify specific interest groups as the pillars of society. Liberty and reliance on central constituencies – whatever the latter might be – can coexist in a democratic society if and only if society has an advanced system of political, administrative, judicial and social checks and balances.

In Ireland, no such checks and balances exist. NAMA and the rescue of bank shareholders and bondholders at the expense of taxpayers could never have happened in societies with modern state infrastructures. It did not happen in the US, where TARP was instantaneously altered to a much more robustly enforceable direct lending and equity takeover. It did not happen in the UK, which adopted a similar approach. It did happen in Ireland and other parts of Europe. Why? In Europe, the judiciary is a function of the political establishment that appoints it, the state is subjugated to the interests of the permanent civil service, and the political realm is dominated by the cartel of vested interest groups i.e. the Social Partners. In Europe, neoliberalism today is an a-ideological deus ex machina for continued propagation of the élitist State in exactly the same way as fascism and socialism were engines of elitism in their turn.

Ironically for their promoters, minorities, the poor and the downtrodden would do much better in a society based on liberal (or in American terminology libertarian) ideals than in their gold-gilded cage of Social Partnership. As Rand noted, libertarians believe that all minorities - rich and poor alike - are the same. To our political élites on the other hand, minorities are divided into Leninesque ‘useful idiots’ (the Social and Environmental Pillars) whose consent to the status quo can be bought for tuppence worth of State subsidies; and ‘powerful conservators’ (Big Business and the Unions) who can provide the power and money necessary for perpetuation of this status quo.

To An Ever Braver World

The maze of interchanges in a small country between sectoral vested interests – political and executive, social, environmental and economic – is informing our ideological and electoral positions. The state is seen as an (at least occasionally) benevolent defender of the interest to which one is aligned. The stronger state, therefore, is just that, a stronger defender. From the intellectual laziness of our academics, to the nearly unadulterated parochialism of our regulatory and legislative interests, to our clan-based politics, the ills of our society are traceable to the historically conditioned inability of Irish society to accept the basic tenet of liberty. We have never learnt that any vested interest, no matter how small, must be treated at a political level as a monopoly-seeking cartel. This, of course, coupled with the recognition that the state itself is a collection of those vested interests, means that the pursuit of liberty for all, requires a coherent limit on the State. The power and financial privileges that have accrued to nearly all of us, as vested interests, have prevented us seeing that.

Economics 13/03/2010: Why Farmleigh report falls flat

I must confess, last week produced a bumper crop of new (and old) 'proposals' for fixing Ireland. Tasc had one (the Letter of 28) - it was utterly unworkable, self-interested and dogmatic - despite the fact that its desired objectives were predominantly positive. Task Force on Innovation had one - it was painfully lengthy, saccharine and dogmatic in its own way. An idea that Ireland can create high-tech jobs bu busloads was simply beyond any support and the analysis produced in Chapter 13 to support this assertion is exceptionally naive.

In between, largely unnoticed, was the missive issued by the Department of Foreign Affairs titled simply "Progress Report on Follow up to The Global Irish Economic Forum".

This unassuming publication is, nonetheless, the official endorsement of the expensive, though originally ambitious (deflated by the DofFA bureaucrats/organizers who went through the original list of invitees with a red pencil removing any potential 'trouble makers' - aka original thinkers) undertaking back in September 2009. It is full of woolly and teary-in-the-eyes stuff that doesn't deserve much attention, except that it puts Ireland Inc to international public view. DofFA aims this report not so much at us, the residents, but at the foreign 'diaspora' - and through them - at international markets.

So let's take a quick scalpel to that boil.

Per DofFA: "The emphasis in the Budget [2010] on encouraging innovation, maintaining Ireland as a friendly and supportive environment for international business, and highlighting emerging strengths in areas such as renewable energy, green technology, scientific research and innovation, all reflect the concerns and views put forward by those present at Farmleigh."

Of course, DofFA would do well to read the Budget. It has a tax break for booze (un-passable to consumers) and a tax break for new cars (passable to German, Japanese and other producers of these). Which part relates to 'encouraging innovation' etc? On Green - there is a new tax, but no 'highlighting emerging strengths'. Page 3 of the said DofFA report therefore already contains a very sever stretch of 'truth in reporting' concept.

The report, worryingly, brings up numerous references to direct and indirect Exchequer financing for expanded post-Farmleigh 'Network' of 'Global Irish' (or shall we call them 'Glorish'?). On our knees economically, we, the resident population will be floating financially such worthy causes as 'regional' Farmleigh-style gatherings around the world, Ministers participation at these, an hereto invisible organization called Irish Technology Leadership Group in Silicon Valley, and one Irish Innovation Centre, plus other activities. 'Glorish Youth Farmleigh' junket is planned as well.

Perhaps the most grotesque (and from my point of view is the idea of going to the Irish diaspora worldwide hat-in-hand to get some cash for the Exchequer. "Diaspora Bond: the Minister for Finance announced in Budget 2010 that the NTMA and his Department will develop a National Solidarity Bond which will be available for investment in 2010. Initially, the bond is expected to be available to Irish residents. The NTMA, the Department of Finance and relevant Departments are examining the feasibility of extending it to non-residents and how to successfully market it abroad, including through Irish Diplomatic Missions."

I commented before on the notion that our Government (and some of its close allies on the Left) have somehow gotten into their minds that they can sell this 'Tin Whistle & Shamrocks' bond for more than they are selling ordinary bonds. It is simply naive. Any yield offered on these bonds will require a premium over ordinary bonds issued to the international investor community. Why? Because this Government has shown to the entire world that it is willing to sacrifice domestic investors for the sake of protecting foreign bond holders. They are doing this with the banks. And as a result, any investor in a 'special' bond will ask for extra return in exchange for surrendering the protection granted to institutional foreign investors.

But read carefully above - there is an idea that such a bond can be marketed to retail investors outside Ireland via our diplomatic missions. Have they heard of MiFID or its equivalent regulations around the world? Imagine:

Our diplomatic mission in, say NYC, with a sign: 'Paddy Bonds: Buy Em Here'. A bureaucrat/ diplomat at the desk. A gentleman walks in and says: "Can you tell me about this fine bond offer?" Our man starts blabbing about Budget support for innovation and the fantastic opportunity to get X% on your investment, should you buy this Y-year bond. Another man walks in. Shows a little card, saying "SEC" at the top and asking to see our mission representative's authorization to sell retail investment products. Zoom forward ten second. The bureaucrat is led in handcuffs, Fox News outside with a camera crew and SIPTU/CPSU rep running after them shouting "Social partners will not stand for such treatment of ordinary workers!". NYTimes headline next day: "Erin Bonds Bust". Within a week - the same happens in all civilized nations protecting their citizens from unauthorized dealers in financial products.

Anyone in Farmleigh scratched their head over this possibility? Or did they all think we can get our missions staff to re-train (in our knowledge economy) to become authorized advisers all around the world? Nope - swept in a collective enthusiasm for 'radical, man, thinking' they just popped out this pearl of wisdom.


Forget all the nearly macabre pedaling of the tourism offers in the report - the ones that occupy several pages. Take a look at the beefy parts:

Section 32: "A new €90 million National Energy Retrofit Programme, ...was announced in Budget 2010. The programme will draw together existing retrofit programmes into a more coherent, overarching framework, leveraging the relationship between energy companies and their customers to promote energy efficiency improvement measures and energy services to end-users. This new programme has the potential to be the most innovative, ambitious, energy-related initiative ever introduced in Ireland. The 2010 activity alone, disbursing €130 million, will support energy efficiency improvements in up to 60,000 homes in 2010, support 6,000 jobs directly and will create energy efficiency savings worth a total of €570 million over their lifetime."

Ok, figures check: how can a €90 million programme disburse €130 million? Do money now grow on the Gov offices lawns? And notice the reference to 'energy companies' and their customers. Of course, most of this funding is therefore destined to settle into ESB, Bord Gais, and Bord na Mona coffers. To promote energy efficiency of the least efficient generators who happen to - courtesy of the state protection - be the dominant market players. But wait, 130 million for 60K homes runs to an average of €2,167 per home. Now apply arithmetic: at least 20-30% of every Government programme is consumed by admin and own costs. Then there's VAT on services and supplies. In real terms, we will be lucky if the €1,198 per house actually gets disbursed. It is better than nothing, but it is hardly qualifies as having "the potential to be the most innovative, ambitious, energy-related initiative ever introduced in Ireland".

The idea is good, don't take me wrong. It is just being devised to suit the wrong crowd - the crowd that got us where we are in terms of inefficient, severely polluting and excessively expensive energy market.

Incidentally - has this anything at all to do with Farmleigh? Nope - it was announced two years before Farmleigh took place and was budgeted for the first time in 2008.


The entire section on economic development - from mid page 8 through mid page 10, accounting for 1/5 of the substantive sections of the report has absolutely nothing to do with Farmleigh. In the end, roughly 1/3 of the report relates to ideas discussed in Farmleigh, with the rest being

• either tripe as the talk about the St Patrick's Day junkets for ministers (as if these never happened before Irish Diaspora gathered in Dublin last September), or
• something that has been announced/planned for before the Farmleigh, e.g. Dermot Desmond's 'Culture Ireland' Uni (don't get me started here).
  

What Farmleigh report does well, then? It shows a deep degree of incompetence and insecurity amongst the political and bureaucratic masters of Ireland Inc. It's comprehensive lack of new ideas, lack of departure from the status quo are frustrating, especially since we know - many of those who were at Farmleigh last September really do have good ideas.

It is simply that DofFA and this Government had no desire to hear them speak their minds. Which brings me to the revelation that was not made before (to my knowledge) about Farmleigh. In months of preparation for Farmleigh, DofFA took over the lists of invitees, prepared by the idea originators and mercilessly cut out all potential invitees they did not approve of. From that list gone were a number of public figures very active in policy debate in this country and internationally. They then added a number of those, deemed by the bureaucrats as representative of the Social Partnership. How do I know this? The original owners of the Farmleigh idea actually told me this a week before Farmleigh took place!

Sounds familiar? Yes - Farmleigh, despite sporting some very good corporate leaders, was just another state-run, state-owned junket, designed to appease our ruling elite. The 12 page report on it that took DofFA 4.5 months to compile reflects exactly this reality.

Economics 12/03/2010: Anglo's latest fun in the sun

In latest development: as Mr Alan Dukes – retired politician extraordinaire – takes over as the Chairman and Executive Chairman of the Anglo. Presumably he will no longer be acting in the interest of the taxpayers – which would, of course, be a conflict of interest for a Chairman and Executive Chairman.

There was a nice question put Mr Dukes on Newstalk – about the extraordinary €10 billion worth of ‘Master Loan Repurchase Agreements’ carried on the banks books (per Anglo’s latest annual report). Mr Dukes didn’t answer that question. But here is what we know:

MLRepos are in effect Central Bank of Ireland repurchase agreements that are so toxic, the ECB refuses to accept them as a collateral for its own discounted lending. So our Central Banks stepped in to hover these off the Anglo’s balance sheet.

Which begs several questions – and I do hope Mr Dukes actually answers these:

1. What exactly are these MLRepos and why are they held by the CB and not ECB?
2. Does Anglo continues to engage in such derivative operations vis-à-vis Irish CB?
3. Is this equivalent to the CB ripping out the decks to keep Anglo afloat – after all, in all banking finance theory, special purpose Repos held by the lowest rank lender of last resort can only be viewed as the last chance corral for a financial lender?

In a Newstalk interview, Mr Dukes did not deny the existence of the MLRepos, but said that these were not a part of the normal funding for the bank. I guess we knew this much already. Anglo, you see, is hoping to move away from this sort of shenanigans in some time in the future, when the normal property markets return, so the bank can too start lending in normal ways.

Really? How many tens of billions of taxpayers funds later would that be, Mr Dukes?

I wish Mr Dukes well in his role. And I am sad to see Donal O'Connor leaving the post - he has great experience and did his best to keep the sinking Titanic afloat.

Economics 12/03/2010: Industrial production

If you believe in fairies and elves and the story of the MNCs carrying out Ireland out of the slump driven by collapse of domestic economy, then you are in a recovery, friend.

On an annual basis production for Manufacturing Industries for January 2010 was 2.3% higher than in January 2009 (chart) per CSO’s latest data.The drivers of this change were:

• Computer, electronic and optical products (-37.2% oops)
• Basic pharmaceutical products and preparations (+11.8% - more like it).
  

In other words, really, folks – fewer PCs many more Viagras. Time to pop that vintage champagne out.

Hold on – there’s seasonality here, clearly, plus volatility. So the seasonally adjusted volume of industrial production for Manufacturing Industries for the 3 month period November 2009 to January 2010 was 2.7% lower than in the preceding three month period.

What happened there?

The “Modern” Sector, comprising a number of high-technology and chemical Sectors – all are MNCs led – showed an annual increase in production for January 2010 of 4.8%.

A decrease of 3.6% was recorded in the “Traditional” Sector (the one our folks at L28 wanted to stimulate via expensive borrowing and semi-state companies – good luck extracting here any sort of meaningful returns on ‘investment’).

More significantly, the seasonally adjusted industrial turnover index for Manufacturing Industries fell 1.5% in the three month period November 2009 to January 2010 compared with the preceding three month period. On an annual basis turnover was 8.8% lower when compared with January 2009. This makes me worry – turnover is down output is up and there is no deflation globally. What’s happening? Have falling value of the Euro been impacting the revenue we collect on transfer-pricing from the US? Likely – inputs prices are appreciating with the dollar, output prices are falling with the euro. In the end, less dosh for us.

PS: what do you think these figures are doing to the hopes of the high value-added private sector jobs creation - the one that promises us to deliver 105K new jobs via IDA and another 150K new jobs via FAS/DETE etc 'Innovation frameworks'?

Let me tell you a quick tale: on the day of Taoiseach's launch of the Innovation taskforce report, TCD academics received a 'No' answer to their joint (with Innovation Centre) application for a post of a lecturer in entrepreneurship and innovation. Knowledge economy, it seems, per some decision-makers somewhere, does not need research and teaching in either entrepreneurial aspects of innovation or business aspects of the same. So much for 'commercializable R&D'... Oh, yes, the post was planned to be self-financing via expanded teaching programmes, as far as I am aware.

Economics 11/03/2010: Replying to Prof Krugman

Updated: 14/03/2010

I have a choice today - to either deal with the notoriously influential article by Paul Krugman, or respond to a large number of responses to my commentary on the Letter of 28.

I will do both in proportional terms, relative to their substantive weight.

On L28 debate:

I received a number of supportive comments, including from the people who are self-identifying with the Left in their traditional views. Many thanks to all who commented. Please, continue to read the blog and comment on its posts.

I received a number of negative comments:

• A large number of simple 'I do not agree...' ones. Thank you for you comments. Hope you continue reading this blog and commenting on other posts in better force;
• A very small number (3) public comments in other venues that were constructive, engaging, one even funny (Mrs G posted one on her Facebook). I linked one of them (the best one, to my judgment) on the original post. Thank you for these. I strongly disagree with their main points, but I am sure we will continue debating these and I am looking forward to this;
• a large number of anonymous, outright rude and bizarre comments.
  

Now to Professor Krugman.

You are all familiar with his article in New York Times (link here). What's wrong with Prof Krugman's exposition?

"Ireland had none of the American right’s favorite villains: there was no Community Reinvestment Act, no Fannie Mae or Freddie Mac."

Sloppy job. Ireland had one Social Partnership and one 'last standing Socialist' Government of Bertie Ahearn (with Bertie's famous exclamation on the point as "I'm one of the last socialists left in Irish politics," (December, 2004)). This dynamic duo (see Mr Ahern's speech on the role of Social Partnership here, especially the sections on Community and Voluntary Sector incorporation into this structure - a clear sign of Social Partnership becoming over-weight on 'Social' agenda) presided over the gravy train of Exchequer (and local authorities, semi-states, Quangoes and Social Partners) feeding off the property boom. If this was not equivalent to the Federal and Local Authorities in the US fueling property boom through their policies, I am not sure what is.

Note: the World Bank confirms the 'social' nature of the Partnership here.

We had a 20% social housing 'dividend' which inflated prices and restricted supply. Local authorities had an option of either exercising the 20% allocation in full, or substituting in financial contributions from developers. They took charge of this subsidy and run with it. We had zoning and planning laws and practices (perpetuated and perpetrated by the State in its various guises) that:

• pushed development into marginal areas,
  
• reduced supply of suitable land,
  
• curtailed re-development of poorly utilized properties,
  
• supported rural small-scale build up and
  
• lavished tax breaks aligned with the National Spatial Strategies and National Development Plans on shoe-box apartments in depressed and depressing areas where few sustainable buyers would opt to live.
  

We had the Government that was taking over 40% of the value of each new unit built in this country in taxes and levies, thus directly benefiting from this artificial scarcity-driven boom.

We topped the cake with a cherry of one Grand Socialist Scheme that envisioned moving people around the country physically - the Decentralization. It required 'volunatry' relocations, but in the end boiled down to giving public sector workers a fine choice - keep your current job or get re-asigned to something else. No matter what, alongside with the State purchasing vast amounts of 'Decentralization'-bound real estate (that now sits unoccupied) the promise of tens of thousands of public sector employees moving to new locations contributed to expectations of price appreciation in remote areas.

We had some other - Stalinesque in the planning terms (not execution, fortunately) schemes - remember the promises of investment and jobs flowing to BMW, the West, the North West? The Western Rail Corridor? Hardly 'market forces' at their best, these boosted expectations of future returns on property. Taking the case of Luas driving appreciation of land in Dublin and applying this to Western Rail Corridor implies that land and property values in the relatively de-populated parts of the country along the northern arm of the route have increased by 15-20% instantaneously upon the scheme announcement.

Just because we did not have the State pushing jumbo mortgages underwritten by state-owned mortgage lenders onto low income households, does not mean that the hands of the Government and its Partners are not imprinted on the facade of our own property bubble.

Instead of all the American Acts, we had the Social Partners telling the Government "we need more construction for our constituents". The Government did as it was told and collected tax revenue in sacks. It run rings around the handsomely paid and complacent regulators and supervisory authorities, who sat on their hands as the bubble was inflating. Most were appointed into their positions as the 'retirement perk' from their life-long complacency filled civil services jobs. Others - because they were 'friends' of the regime (recall Mr Ahearn famous admission on RTE). The Social Partners weren't cheering them on, they were shouting 'We need more...'. Inchdoney Accord resulted. And appointments of their friends to the positions of power.

The new NDP - with it 'social investment' taking up a third of the funds allocated for the entire 'capital' programme followed. Social housing lists swell in response, as did the coffers of local authorities, who spent the cash on grandiose Palaces of Peoples - their own headquarters. And Gateways to Excellence - shining campuses for FAS and numerous ITs - that remain empty or half-empty. The merry-go-round was spinning.

So we pushed jumbo mortgages from our non-State banks onto ordinary folks to pay for the above largess of the 'Social' State and its 'Social Partners'. Hardly the forces of 'market capitalism' these were.

We distorted returns on every other form of capital:

• Productive physical capital carried a 25% direct rate of tax or 12.5% corporate rate, or both - depending on whether you were a small or a medium business;
• Human capital was taxed at 42%, then 41%, now up to 56% margins;
• Currently vacant apartments sit taxed at 0%.
  

The 'Left' did occasionally protest against the latter - never against the former, and often against the 'low' physical capital taxes. But these protests were not about the bubble - they were about the Irish Left's demands for even more state transfers. By 2005-2007 they were calling on the Government to start pushing property development into becoming a vehicle for financing not only domestic welfarist policies, but even the aid to foreign countries.

The squeeze on the property market was complete - the supply was artificially restricted, demand was artificially inflated and the Government was actively 'talking the market up'. The banks were encouraged to lend and the regulators were directly selected to be complacent, inactive and on some occasions - outright unsuited to run the complex world of finance. Our former Governor of the Central Bank had no idea he could do anything to alter reserve requirement ratios on Irish banks - he was a career bureaucrat, not a central banker.


Prof Krugman says that "What really mattered was free-market fundamentalism." And refers to Ronald Reagan. Ireland never had a single Ronald Reagan moment in its history. Where Reagan believed in the right of people to engage in free enterprise, Irish Government only believed in the right of the State to tax the free enterprise. Post 2002 EU ruling, most of the taxing took place through indirect means, while the Government maintained a low tax rhetoric. Before 2003, during the height of the 'free-market fundamentalism' we had two-tiered tax system, with a 10% or less tax for big MNCs and a punitive 32% for mere mortals. MNCs were encouraged into this country by the wavers and indirect subsidies that reduced their indirect taxes which were levied through the system of state-controlled bodies and companies. This can fool outsiders like Prof Krugman and some insiders (e.g. the Letter 28 authors) to believe that Ireland was some sort of the Friedmanite Happy Land of free markets, but it does not change the reality.

Let me postulate the following theorem to Prof Krugman:

"Independent of how many fingerprints a forensic analyst can collect at any economic crime scene, invariably, there will be one set of fingerprints always present - that of the State"

And a corollary:
"These fingerprints will invariably lead an investigator to something with a word 'Social' or its derivative on it as a core entity partaking in the event".

'Social' as in 'Socialist'. Doesn't really chime with 'free-market fundamentalism'...

Per arguments above, QED.


Note: Hat tip to Anonymous on typos.